Arguably the two biggest scandals of the early 2000s belong to Enron and Tyco. Of course, investors have short memories, and many have long forgotten the pain that rippled through the markets when these leading companies felt their demise.
But while market eras and leading stocks change, human nature doesn’t. There will always be management teams who rely on their accountants to manipulate their business’ short-term financial performance. After all, accounting is the language of business.
For example, a company may “stuff the channel” – or accelerate sales in this quarter – at the expense of next quarter’s sales. And viola – the company magically boosted its revenue for the current quarter.
Or, they might manipulate cash flow through unsustainable activity, boosting it in the short term and making free cash flow look better than it actually is. They might even understate their expenses in the current quarter, which, again, helps in the short term, but sets them up for future disappointments.
This kind of financial manipulation has already started to beat down a number of companies.
That’s why I’ve made my own list of the top 100 companies, based on a number of metrics – revenue quality, cash flow quality, valuation, shareholder yield, and earnings quality yields. Here’s a sample of that list:
These are actually the top 10 in my list of 100. But I’m not saying to go out and buy these companies. I’m just saying, based on my own methodology for picking stocks, these are the top 10 who have the odds stacked in their favor to outperform overtime.
You may find the next big winner in that list. I can’t promise that. But more importantly, it pays to have a consistent process when it comes to picking stocks like I do.
Though right now, it’s probably a better idea to make sure you’re not invested in any companies practicing the kind of financial tomfoolery I described above.
To get a thorough run-down of how to identify these kinds of companies, we’re offering a free copy of my book What’s Behind the Numbers? to any Dent Research reader – you just pay the shipping.
Just remember – and this bears repeating – we’re still in the riskiest end of the spectrum when it comes to allocating more capital to stocks. Cash out now, and wait for the next opportunity to strike.
John Del Vecchio
Contributing Editor, Dent Research